It Isn't Time to Walk Away

05/14/2012 9:00 am EST

Focus: MONEY MANAGEMENT

Terry Savage

Author, The Savage Truth on Money

One person's debt forgiveness doesn't solve the problem...it just becomes someone else's obligation, writes MoneyShow personal finance expert Terry Savage.

A huge and very dividing issue is brewing in America. It will divide us along generational lines and financial lines.

Bills have been introduced in Congress to help debtors walk away from their obligations—whether mortgages or student loans. And judging from the following questions I’ve received, there is a great concern that we’re creating the wrong incentives. Here’s what some of you had to say:

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My son paid his student loan. I agree that these kids are getting a bad deal, but what are they and their parents thinking when they borrow this money?

Our Congress needs to do something about the interest rates besides getting reelected. But these kids can't be allowed to walk away from paying for the education they received as some have proposed. Don't we have enough people walking away from their obligations?

 If I don't seem very sympathetic, it is because my wife and I have worked really hard to pay our debts, we live within our means, and we are really trying to put away enough to retire on. 

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I just read that Bank of America is going to give 200,000 homeowners a reduction of up to $100,000 in their mortgages—if they are at least 60 days behind on their mortgage payments.

Why are we rewarding people who are delinquent—and won’t that encourage even more people to stop paying? I only ask because my family has been struggling to keep paying our mortgage. What do we get?

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These two similar questions get to the heart of the same issues: personal responsibility and incentives for behavior. This is truly a national issue. We are a country built on giving people second chances. After all, many of our original settlers came to this country after fleeing debtors’ prisons in Europe.

On the other hand, the basic principles that made America different from any other country revolve around personal responsibility. It’s the other side of the coin of opportunity.

America was built on the idea of freedom to pursue life, liberty, and individual happiness. These were considered rights inherent in human nature, not a gift from the “state.” And along with the opportunity came the responsibility for personal behavior, and the risk of failure and loss.

Today that issue of personal responsibility revolves around debt—personal debt, public debt, and our national debt. Consider these issues:

  • We allow, even encourage, personal bankruptcy as a way to wipe out debt and start over. But is it getting out of hand, and creating the wrong incentives?
  • Should student loans, which currently can’t be wiped out in bankruptcy, be forgiven—just because we’re in tough times? What kind of lesson is that?
  • Should city and state pensions be adjusted because we know we can’t pay them in the future? If a state adjusts its obligations, shouldn’t we get the same chance? Or should we just pay higher taxes to make good on our promises?
  • Our Congress can’t come up with a budget, or a plan to reduce our debt. Will we eventually be forced to default, or print money (inflation)? Why do we re-elect them? What kind of incentive is that?

Incentives do matter. People do respond rationally to the incentives we offer. It’s fine to say we need to increase financial literacy. I’m surely on the side of that solution, but it won’t help the existing debt problem. And casting blame isn’t very helpful either.

So what incentives do you think we should be creating now to deal with our debt? And what should we NOT be doing? I’d like to hear from you.